The pros and cons of going public

By Shawn Malcolm

Shawn Malcolm is an investment advisor in ScotiaMcLeod’s North Toronto office.

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Since 1993, we have seen several Canadian film and television production companies go public. In 1993 and early 1994, the markets were receptive to this growth industry, but this window of opportunity closed as investors became less willing to take risks.

This article examines the pros and cons of public listing, as well as taking a look at the general market reception of seven recent Canadian public offerings.

Access to capital is a key ingredient for any growing industry, and equity is quite often more desirable than debt. Growth companies seeking a cash infusion through equity offerings need to be aware of the advantages and disadvantages of going public.

First, let’s take a look at the requirements of listing on the Toronto Stock Exchange.

1. The company must have an earnings record. The latest fiscal year must show net income of $100,000 before tax and net cash flow of $400,000 before tax.

If the company has significant tangible assets, a past record of earnings is not mandatory, however, the film and tv industry is not capital intensive. ScotiaMcLeod Telecommunications and Entertainment analyst Jonathan Robinson suggests that a history of profitability, stability and growing earnings is desirable.

2. Generally, $1 million of net tangible assets is required. However, there is no minimum if certain profitability and cash flow tests are met.

3. Listing on the tse requires that at least one million shares be freely tradeable, and they must be held by at least 300 public shareholders who own at least one board lot each. A board lot is 100 shares of stocks trading over $1.00.

4. The market value of the shares issued must be in excess of $1 million.

5. Companies must have adequate working capital to carry on business; at least $500,000 in the absence of proven reserves.

Aside from meeting these conditions, there are a host of other considerations. Private companies which are considering a public issue should consult an investment banker, who provides counsel on the timetable of events leading up to the issue, and ongoing advice on all aspects of publicly listed status.

The investment banker will aid in the following preparation:

1. Timing of the issue to ensure a strong reception.

2. An auditor must be retained to prepare financial statements for the last five years. Legal counsel must also be retained to ensure that all securities laws are adhered to.

3. The relevant securities commission must be notified of intent to issue.

4. A preliminary prospectus must be drafted and filed with the provincial securities authorities. Any deficiencies must be amended.

5. A printer must be engaged for marketing memorandum, preliminary and final prospectus.

6. The prospectus must be translated into French.

7. Institutional luncheons and ‘road shows’ are used to generate interest in the issue.

8. The investment banker or lead underwriter forms a banking group and selling group to distribute the issue.

After distribution, the investment banker will provide advice on how to abide by securities laws, disseminate news, etc. Indeed, a whole book could be written on this process, but this is a general guideline.

The advantages of public listing are:

1. Prestige and goodwill. Investors realize that a listed company must meet and maintain certain standards.

2. Better credit access. Creditors can easily see the market value of a company and compare it to the boom value of its assets. If market value is greater, a strong case can be made for more credit.

3. Future debt financing is easier. Debt that is convertible into equity (convertible debentures) or debt with purchase warrants attached can be issued. These are ‘sweetened’ forms of debt that can often be issued at reasonable rates.

4. Increased public awareness. Any material changes in the company’s affairs are quickly disseminated to the public, drawing new shareholders and performing a market function.

There are also disadvantages:

1. Additional controls on management including escrow agreements and management contracts that typically extend up to three years. An escrow agreement prohibits certain shareholders from selling their shares for a specified period of time after the issue.

2. Cost of issue and listing. An annual listing fee must be paid to the stock exchange, as well as an initial listing fee ranging from $3,500 to $50,000 depending on the number of shares to be listed. There are also printing, marketing, translation and auditor fees relating to the new issue.

3. Management of a public company must contend with the demands for investor communications.

What does the investor look for in this industry? Adequate financing is one thing the market likes to see in place. A reliance on government financing is seen as undesirable. Since the film and tv industry relies on the revenue-producing skills of people rather than hard assets, the market looks for management with a track record. A production company should have a track record with brand-name appeal. Investors like to see familiar names and projects in a prospectus. The market also likes to see stringent accounting procedures and doesn’t like to see the amortization of film assets over three years.

In general, investors look for growth potential through able management and a clean balance sheet. In a period of high real interest rates, investors demand the potential for large capital gains in a small cap stock (cap refers to capitalization – the product of the number of shares outstanding and the market price per share, i